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The Severn Company plans to raise a net amount of $270 million to nance new equip-ment and working capital in early 2002. Two alternatives are being...

The Severn Company plans to raise a net amount of $270 million to finance new equip-ment and working capital in early 2002. Two alternatives are being considered: Com-mon stock may be sold to net $60 per share, or bonds yielding 12 percent may be issued.The balance sheet and income statement of the Severn Company prior to financing areas follows:

The Severn Company: Balance Sheet as of December 31, 2001 (Millions of Dollars)
Current assets$ 900.00Accounts payable$ 172.50Net fixed assets450.00Notes payable to bank255.00Other current liabilities225.00
Total current liabilities$ 652.50
Long-term debt (10%)300.00
Common stock, $3 par60.00
Retained earnings337.50
Total assets$1,350.00Total liabilities and equity$1,350.00

The Severn Company: Income Statement for Year Ended December 31, 2001(Millions of Dollars)
Operating costs2,227.50Earnings before interest and taxes (10%)$ 247.50Interest on short-term debt15.00
Interest on long-term debt30.00Earnings before taxes$ 202.50
Federal-plus-state taxes (40%)81.00
Net income$ 121.50The probability distribution for annual sales is as follows:

0.30 $2,2500
.40 2,7000
.30 3,150

Assuming that EBIT is equal to 10 percent of sales, calculate earnings per share under both the debt financing and the stock financing alternatives at each possible level ofsales. Then calculate expected earnings per share and EPS under both debt and stock financing alternatives.

Also, calculate the debt ratio and the times-interest-earned (TIE)ratio at the expected sales level under each alternative. The old debt will remain out-standing.

Which financing method do you recommend?

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